Key Factors Influencing Choice Of Capital Structure

Capital Structure is that mix of debt and equity that a firm or rather a company uses to finance its long-term activities. Lets look at some of the factors influencing choice of capital structure of a firm;

  1. Cost of capital: This refers to what is paid to the provider of capital for capital they have advanced to the firm. If the cost of capital is lower, the firm may end up using more from such asĀ  source of finance. For instance when cost of debt is lower than cost of equity, the firm will use more debt than equity since the cost of debt is not higher .
  2. Size of the company: Lets look at this in terms of accessibility. Here, Larger and well established companies may have wide and easier access to capital markets and hence may use both equity and debt.
  3. Nature of the assets of the company: Firms that have more long term assets are more to use debt in financing its activities since these long term assets can be pledged as security for debt.
  4. Tax benefit: A firm may use more debt in financing to take advantage the benefit associated with it which is interest tax shield.
  5. Management attitude towards risk: This will depend on the attitude of the managers toward risk whether they are risk neutral, risk seeker or risk averse. If the managers are risk averse, meaning they are reluctant to take risk, they will end up using less debt than equity in order to reduce financial risks such as bankruptcy.

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